Monday Mondays: The Power Of A Strong Dollar

Tom: Good morning, Mellody. You are here today to explain what the strong dollar means.

Mellody: Good morning! I am, Tom. Over the past few months, you have probably heard people talking about the strong dollar – and for good reason! The dollar has been gaining ground against all major currencies. The euro dropped to a valuation of $1.10 last week, the lowest level in eleven and a half years, and a dollar buys 25% more yen than it did a year ago. This surge in our currency’s value is big enough to change the economic interactions between the world’s largest economies, and it will have ripple effects for countries, companies and individuals.

Tom: A strong dollar is simply a better exchange rate, right?

Mellody: That’s right, Tom. The terms weak dollar and strong dollar are used in the foreign exchange market to describe the relative value of the U.S. dollar against other currencies. As the dollar increases in value compared to another currency, it buys more of the other currency than it did before. And this has impacts in many sectors of the economy.

And the reason the dollar is doing well against other currencies is really straightforward. The American economy is doing very well relative to the rest of the world’s economies. In recent years we have seen Europe and Japan struggle to emerge from the global economic downturn. Developing economies like Brazil and Russia are experiencing instability, and China is slowing fairly dramatically, all while the U.S. is seeing consistent growth. Because of this, you have greater demand for the dollar.

Tom: What is the overall impacts of this?

Mellody: A stronger dollar has some benefits and some drawbacks. One big area where we are certain to see big impacts is trade. American companies that export their product overseas will take a hit, because a strong dollar makes their products more expensive, so their price competitiveness has fallen. On the other hand, companies that import components should see benefits, as should retailers who are importing their wares. A strong dollar means that products made outside of the United States will be cheaper in relative terms than they were before.

Tom: Will this have an impact on the market?

Mellody: Probably not a broad impact. A recent report from Barclays found that S&P 500 returns are generally unaffected by what the dollar does. Historically, stocks don’t sink on a weak dollar or boom in times of a strong dollar. Instead, specific industries are impacted for different reasons. A strong dollar makes materials produced overseas more expensive for American companies.

Because of this, energy and materials companies traditionally underperform in times of a strong dollar, as commodity prices cut into profits. The same is true for companies that do business overseas and have to bring those profits back, exchanging currencies in the process. The bad exchange rates mean that it will hurt these profits. Companies like Coca-Cola and other consumer goods firms will be affected.

There are some positive impacts. As investors shift their money to America to protect its value and take advantage of America’s relative economic strength, it drives up the value of American assets, including stocks and bonds. This benefits American investors, makes consumers richer, and enables American companies to finance their operations on the cheap, which all help the markets.

Tom: What does this mean for consumers?

Mellody: Well Tom, a stronger dollar generally means good things for the consumer. As I mentioned, imports are cheaper for Americans. This means everything from your normal consumer goods made in the developing countries to luxury goods being imported from Italy or France will cost you less. Another big American import is oil, and because oil is priced in dollars, Americans are actually getting a bigger net gain from lower oil prices than our foreign counterparts.

Lastly, if you are planning any overseas travel, the stronger dollar is definitely going to make your time abroad cheaper. In general, a strong dollar is good for the consumer, and keeps more money in our pockets, and your portfolio should get a boost too!

Mellody is President of Ariel Investments, a Chicago-based money management firm that serves individual investors and retirement plans through its no-load mutual funds and separate accounts. Additionally, she is a regular financial contributor and analyst for CBS News.